“Hedging is all about reducing the price risk—not making or saving money. But what these banks enticed these firms into is speculation. This is taking risk to make profits,” said Rajwade, a reputed risk management consultant, whose firm AV Rajwade and Co. has been advising about a dozen small and medium firms that collectively have already reported estimated losses in excess of Rs300 crore arising from their exposure to derivatives.
Deepankar Sanwalka, head of the forensic wing of audit and consultancy firm KPMG India, too, said some of these transactions are in violation of RBI’s derivatives guidelines. “The issue is not as simple as some of the banks are projecting. The documentation of such contracts is not always watertight and if the firms decide to go to court, the contracts can be null and void,” added Sanwalka, who has so far investigated at least two firms that have faced around Rs200 crore of losses on account of their exposure to derivatives. One of them is Hexaware. While Shroff said that all contracts are backed by genuine underlying transactions, Desai of J Sagar Associates claimed there is no underlying transaction for some of the deals that his firm has investigated.
There are two sets of RBI guidelines that banks, consultants and lawyers swear by— comprehensive guidelines for derivatives, a 30-page document, dated 20 April 2007, and a 53-page master circular of risk management and inter-bank dealings, released on 2 July 2007.
According to Alpana Killawala, RBI spokesperson, RBI insists that such transactions must be “suitable” and “appropriate” for the end users. Besides, every derivatives contract must have an underlying transaction. RBI norms also say that when firms enter into such derivatives contracts to reduce their costs, such transactions must not increase “risk in any manner” and should not “result in net receipt of premium by the customer.” RBI itself isn’t conducting a special or separate investigation into the role of banks in the losses some companies have incurred, said Killawala. However, the Indian central bank’s annual inspection exercise is on a high alert for such deals.
Desai of J Sagar Associates alleged that banks have paid premium to these firms upfront to entice them. “Typically, they are paid $100,000 upfront but such payments are not shown as premium...,” he added.
One ‘underlying’
In private, some bankers admit that there could be a few firms that used the same “underlying” for many derivatives transactions that they have entered into with different banks without their (the banks’) knowledge but they vehemently contest allegations of mis-selling. “Every phone call made from our treasury is recorded. You can hear the tape and decide whether we enticed them,” said the CEO of a private bank who did not wish to be named.
Kotak Mahindra’s Gupta said that all derivatives contracts of the bank follow the International Swap Dealer Association (Isda) guidelines. Paresh Sukthankar, executive director of HDFC Bank, said: “We proceed only after getting the board resolution from a firm and a confirmation that their risk management policy is in place.” HDFC Bank also follows Isda norms.